Even Greece Exports Rise in Europe’s 11% Jobless Recovery

Former European Central Bank President Jean-Claude Trichet said in a March 3 interview, “The countries that were highly imbalanced are undoubtedly, progressively, but very effectively, correcting these imbalances.” Photographer: Junko Kimura/Bloomberg

From Ireland to Spain, the austerity demanded by policy
makers in exchange for aid amid three years of debt woes is
starting to deliver the competitiveness needed to restore
economic growth even as the turmoil risks reigniting in Cyprus.

At the price of a doubling in unemployment and near-10
percent plunge in labor costs, the so-called peripheral euro
nations are reviving manufacturing and trade. In Spain, exports
reached a record 222.6 billion euros ($287 billion) in 2012. PSA
Peugeot Citroen is hiring there and in Portugal.

“The countries that were highly imbalanced are
undoubtedly, progressively, but very effectively, correcting
these imbalances,” former European Central Bank President Jean-Claude Trichet said in a March 3 interview. “The current-account deficits of countries that have been under stress
diminished over the last years considerably.”

Elected officials are racing to translate Trichet’s
rebalancing into increased incomes to avert a lost decade of
mounting debt and unemployment.

Joblessness already tops 25 percent in both Spain and
Greece, while protesters have taken to the streets of capitals
and on at least two occasions set buildings ablaze in Athens.
Just two of 14 euro-zone government leaders have kept their
posts in elections since late 2009 and extremists such as Golden
Dawn in Greece are gaining support.

“If declining spreads or an improved balance of payments
are economically crucial, they are of little comfort to people
who fear losing their job or struggle to find one,” European
Union President Herman Van Rompuy told reporters March 14 after
a summit eased the shackles of budget rigor.

Countering Warnings

At Morgan Stanley, chief international economist Joachim
Fels cites the productivity gains as reason to turn more upbeat
about the euro’s longevity, rebutting the warnings of economists
such as Paul Krugman and Martin Feldstein that nations may need
to leave the euro to spur efficiency via a cheaper currency.

“The internal rebalancing in the euro area is
progressing,” said Fels. “Some of them, especially Spain but
also Portugal not to speak of Ireland, are regaining
competitiveness.”

A key proxy for competitiveness is an economy’s current
account, the broadest measure of trade. It shows improvement
across the periphery nations whose deficit and debt woes had
threatened to swamp the euro.

Narrowing Deficits

The combined account of Greece, Ireland, Italy, Portugal
and Spain narrowed to a deficit of 0.6 percent of gross domestic
product at the end of last year from 7 percent in 2008 and will
be in balance later this year, according to estimates by Holger
Schmieding, chief economist at Berenberg Bank in London.

While a slide in imports accounts for some of the
correction, Greece boosted its exports outside the EU by about
30 percent in the fourth quarter of 2012 from the previous year,
while Italy’s rose 13 percent in January from a year ago, he
said.

Companies are taking advantage of the cost squeeze. Nissan
Motor Co., Japan’s second-biggest carmaker, said Feb. 4 it would
build a new compact family car at its Barcelona plant and invest
130 million euros after reaching an agreement on improved
productivity.

Ford Motor Co. said at the end of last year it will
increase capacity near Valencia as it shuts plants in the U.K.
and Belgium. Peugeot, which is cutting workers in its home
market of France, is also lifting output in Spain and Portugal.

Ireland Expansion

In Ireland, U.S. companies such as EBay Inc., Google Inc.
and Facebook Inc. all have expanded in the past two years,
taking advantage of a corporate-tax rate of just 12.5 percent
compared to Spain’s 30 percent.

Investors can benefit from the “structural reforms which
can transform Europe’s competitive landscape” by anticipating
gains in stocks, says Aaron Barnfather, who helps manage the
equivalent of $140 billion as director of European equities at
Lazard Asset Management Ltd. in London.

The metamorphosis is known as internal devaluation -- the
result of the policies demanded by German Chancellor Angela
Merkel as the cost of Europe’s pre-eminent power backing
bailouts. Prevented by membership of the euro from driving down
currencies, governments and companies are squeezing labor costs
to spur productivity.

By making goods relatively cheaper to churn out, a
country’s products become more attractive to overseas buyers,
mirroring the effect of a weaker currency. That creates new
engines of growth, replacing domestic demand hurt by government
spending cuts or the collapse of ailing local sectors such as
Spanish property.

‘Most Undesirable’

The approach still provokes criticism. Nobel laureate
Joseph Stiglitz calls the mix of internal devaluation and
austerity a “toxic combination.” Forcing down wages and prices
will only increase the debts of governments and families, he
wrote in a column for Project Syndicate this month.

Without exports, Europe’s performance would have been even
worse in recent years. Ireland’s economy would have been 4
percentage points weaker without net exports since 2008,
Greece’s 3 points and Portugal and Spain 2 points, according to
Citigroup Inc. Trade deducted from growth in the pre-crisis
years.

Spain’s Gains

The forced restructuring resulted in Spain reducing social-security payments from companies, raising the retirement age,
making it easier to fire workers in downturns and preventing
unions from clinging to boom-time wage deals.

A February study by the OECD showed Greece scoring 0.92 out
of a possible one for meeting the pro-growth policy changes
suggested by the club of rich nations since 2010. Ireland and
Portugal scored about 0.8 and Spain about 0.7.

For citizens of Europe’s periphery, the downside of the
economic revamp in these initial stages is lower wages and
greater unemployment.

The euro area as a whole, with an average unemployment rate
of 11.9 percent in January, is suffering its second recession
since 2008. A slump this year would result in the first back-to-back annual contractions since the euro’s introduction. Italian
voters are rebelling at the ballot box against reforms and
austerity there.

‘Dark Clouds’

“In the periphery, there are dark clouds in the form of
recession and unemployment,” said Huw Pill, chief European
economist at Goldman Sachs Group Inc. in London and a former ECB
official. “But there is a silver lining to these clouds in the
form of an adjustment process that is necessary, albeit
painful.”

While Pill says it may take years to return economies to
full health, calculations by his team suggest transformation is
under way.

On average, the periphery is about halfway to eliminating
large structural current-account deficits, which allow for
declines related to recession-driven weaker import demand,
estimates Goldman Sachs. Greece, Portugal, Spain and Ireland
also now need to reduce their real exchange rates by about 10
percentage points less than they did two years ago.

The price they’ve paid has already been steep on the basis
of lower wages.

Labor Costs

A November study by Berenberg and the Lisbon Council, a
Brussels-based research group, found unit labor costs fell 10.5
percent from 2009 to 2012 in Greece, 10.3 percent in Ireland, 6
percent in Spain and 6.1 percent in Portugal. Over the entire
euro-area they gained 1.5 percent.

By contrast, Germany’s fell 4.1 percent from a peak in 2003
to a trough in 2007, a period which helped revive what was once
the Sick Man of Europe and which is now credited with enabling
it to have dodged the worst of the crisis.

The OECD today published an index showing that relative
labor costs in Spain and Portugal have now dropped below
Germany’s for the first time since 2005.

The test is whether the cheaper and greater availability of
labor is enough to attract investment and hiring or ends up
leaving economies a wasteland. Youth unemployment has already
surged, with about half of Spaniards under 25 jobless, and a
third of Greeks facing poverty.

“It’s potentially good for the economy but only if it
results in faster investment,” said Bert Colijn, a Brussels-based economist at the Conference Board and co-author of a
January study suggesting economic reform may be having a
positive effect. “If not then there’s a downward spiral risk.”

Mirror Image

It’s the mirror image of the euro’s first decade, when
historically low interest rates in the periphery fueled
inflationary spending booms, reflected in credit bubbles and
deteriorating current accounts and government budgets.

Irish home prices quadrupled in the decade through the
mid-2000s and those in Spain more than doubled. Greece’s budget
deficit ballooned to 15.6 percent of GDP in 2009, while
Portugal’s widened to 10.2 percent.

The good times began to unravel in 2009, when Greece
admitted its budget math was wrong, sparking a crackdown by
investors on fiscal profligacy and investment excesses.

Interest rates spiked from Dublin to Madrid, with the yield
on Ireland’s eight-year bond reaching a record 15.7 percent in
July. Spain’s 10-year bond yielded 7.75 percent the same month.
Credit default swaps insuring Spanish debt peaked at 640 basis
points and those for Ireland hit the equivalent of 1,181 basis
points.

Draghi’s Defense

Following four bailouts, a semblance of calm was restored
after ECB President Mario Draghi’s July 2012 vow to do
“whatever it takes” to defend the euro.

Still, the crisis risked blowing up anew this week after
European finance chiefs agreed to an unprecedented tax on
Cypriot bank deposits as part of a 17 billion-euro rescue. The
absence of a government in Italy and Greece’s struggles to meet
the terms of its bailout present other flashpoints.

Spanish credit default swaps are now under 300 basis points
and Ireland’s below 200 basis points. It now costs Ireland 3.7
percent to borrow for eight years and Spain 5 percent for a
decade.

The rebalancing challenges the likes of Princeton
University’s Krugman and Harvard University’s Feldstein, who
repeatedly recommended some nations consider taking time out of
the euro to regain competitiveness via devaluation. Krugman told
Bloomberg Television on Feb. 15 that he is surprised Greece
hasn’t left the euro yet, though an exit is “more likely than
not.”

Exit Costs

“The costs of staying in and making the euro work, while
high, are less than the costs of exiting or try to break it
up,” said Barry Eichengreen, a professor at the University of
California, Berkeley, and an author of a history of the European
economy.

That’s not to say the price of membership isn’t painful or
will bear fruit soon. The smaller trade imbalances really
reflect a collapse in demand for imports as consumers and
companies hunker down, says Thomas Mayer, an economic adviser to
Deutsche Bank AG. The Frankfurt-based bank this month cut its
forecast for the euro area to show it contracting 0.8 percent
this year rather than the previously predicted 0.3 percent.

‘Not Healthy’

“At this stage it is still demand destruction which has
helped current-account deficit countries balance their
accounts,” said Mayer. “It’s not a healthy situation.”

Economists at Societe Generale SA calculate that with the
exception of Ireland, unit labor costs have risen since 2008 if
no change in employment is assumed. They also say countries will
need to run even healthier current accounts than now if they are
to stabilize the debts they owe abroad.

Those with hope look to Germany as a model after it revived
its economy from the overhaul following the fall of the Berlin
Wall. Pushed through by then-Chancellor Gerhard Schroeder, the
so-called Agenda 2010 was a package of labor reforms and welfare
cuts.

While it prompted strikes as unemployment reached a 12.1
percent post-war high and contributed to Schroder’s electoral
defeat, it is credited with reducing Germany’s unemployment rate
to a post-reunification low of 6.8 percent in December 2011.

“No one is snickering at Germany’s economic model now,”
German Finance Minister Wolfgang Schaeuble said in a March 14
speech to Bloomberg’s Germany Day conference in Berlin.